On Balance

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When Robert S. Kaplan and David P. Norton published their Harvard Business Review article, “The Balanced Scorecard– Measures that Drive Performance,” in 1992, they had no idea they were about to launch a revolution. They were simply pointing out the shortcomings of using only financial metrics to judge corporate performance, and urging companies to measure such factors as quality and customer satisfaction as well.

By the thousands, companies embraced the idea. A balanced scorecard became the hallmark of a well-run company, and a whole new consulting specialty sprang up to help companies create one for themselves.

Today, many companies say the scorecard is the foundation of their management systems.

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It is fair to say that the balanced scorecard has served its creators well, too. Since the original article and subsequent book were published, Kaplan, the Marvin Bower Professor of Leadership Development at Harvard Business School, and Norton have helped hundreds of companies implement the scorecard and have lectured in more than three dozen countries about it. In addition, Norton left his position as head of Renaissance Worldwide two years ago to become founder and president of Balanced Scorecard Collaborative Inc., a Lincoln, Massachusetts­based firm that facilitates the global use and awareness of the scorecard.

Recently, the duo also found time to write a sequel, The Strategy-Focused Organization (Harvard Business School Press, 2001). In it, they describe the evolution of the balanced scorecard from measurement system to a system for managing change. They examine its impact at some of the 200 companies that have implemented it, including Mobil Oil Corp., AT&T Canada, and Cigna Insurance. “For the first time,” says Kaplan, “we’ve been able to document that it works.”

Recently, Kaplan and Norton discussed the impact of the balanced scorecard with CFO deputy editor Lori Calabro, and argued its merits as a tool for effecting corporate strategy.

When you developed the balanced scorecard almost 10 years ago, did you have any idea how pervasive it would become in Corporate America?

Kaplan: I think not. We really set out to solve a performance measurement problem: Why are financial measures alone unable to capture the value-creating activities of contemporary organizations? The balanced scorecard was the solution to that. What we could not have anticipated was that it was also a solution for a much bigger problem: organizations’ inability to implement new strategies and to move in new directions, particularly directions focused on customer-value propositions.

Norton: In addition, neither of us appreciated that the approach was hitting at the fundamental question in the New Economy, which is, “How do I create value from intangible assets?”

How widespread is the use of the balanced scorecard, really?

Norton: Bain & Co. does a survey every year of the management practices in large companies. This survey indicates that in North America, about 50 percent of Fortune 1,000 companies [are using the scorecard], and in Europe somewhere between 40 and 45 percent. I was just down in Australia. There, research done by one of the universities indicates that about 35 percent of companies claim to be using a balanced scorecard.

What about the other 50 percent of companies? Are they misdirected?

Norton: The approach has probably moved through the large organizations [first], because they tend to be more in tune with current management concepts.

Kaplan: We find that there needs to be a style of openness and transparency present [in order for the scorecard to be adopted]. Senior executives must want to communicate the objectives of the organization to everybody. Not all executives have that style. And, of course, until the new book came out, there had not really been any documentation that this works.

What are the main features of an organization that successfully uses the balanced scorecard to identify strategic goals and realize them–a so-called “strategy-focused organization”?

Kaplan: Each organization we studied did it a different way, but you could see that, first, they all had strong leadership from the top. Second, they translated their strategy into a balanced scorecard. Third, they cascaded the high-level strategy down to the operating business units and the support departments. Fourth, they were able to make strategy everybody’s everyday job, and to reinforce that by setting up personal goals and objectives and then linking variable compensation to the achievement of those target objectives. Finally, they integrated the balanced scorecard into the organization’s processes, built it into the planning and budgeting process, and developed new reporting frameworks as well as a new structure for the management meeting.

But how do you know it works?

Norton: Take Mobil. When they started the process in 1993, they would conduct an annual employee survey and ask questions such as, “Do you understand the strategy? Do you understand what we’re trying to do with our customers, with quality, safety, and things like that?” Initially, they found that only 20 percent of the workforce understood the strategy. Five years later, that number was 80 percent. And the foundation for Mobil’s subsequent success was its ability to get that 80 percent of the workforce to understand what the corporation was trying to do, and then tailor their own jobs and their own priorities to support that strategy.

But, unlike Mobil, firms often hesitate to link the scorecard to compensation.

Kaplan: They should hesitate, because they have to be sure they have the right measures [on the scorecard]. They want to run with the measures for several months, even up to a year, before saying they have confidence in them. Second, they may want to be sure of the hardness of the data, particularly since some of the balanced scorecard measures are more subjective. Compensation is such a powerful lever that you have to be pretty confident that you have the right measures and have good data for the measures [before making the link].

What about data integrity? You mentioned that the nonfinancial measures are often eyed suspiciously because they can’t be audited. At least with financial measures, we have the SEC and FASB standing guard.

Kaplan: That’s an important issue. Many organizations are defining metric owners–a department or an individual in charge of collecting the data, who is typically somewhat independent of the line business units that are being measured. Ultimately, the scorecard should have some degree of auditability and [require] an expanded role for the internal audit function.

Some finance executives say they won’t implement the complete scorecard because of the rigorousness of the theory. They’d rather adopt a KPI [key performance indicator] system because it’s more flexible.

Norton: When you have KPIs, you can have 20 or so random measures. From that point on, you’re still going to have to do the same amount of work. You’re going to have to build an information system, have management staff sit down and review the data every month, and tie it to compensation. The only difference between a bad balanced scorecard and a good one–which would be one that describes your strategy–is the effort that has to go into the front end, with the executive group coming together to agree that this is the strategy and this is how they’re going to measure it. If somebody doesn’t want to do that, they’re essentially viewing the scorecard as a measurement system as opposed to a system to manage change.

Kaplan: You’ve got us into an interesting area. What is the role of the CFO in this process? Speaking a little simplistically, I think we find two types of CFOs. The first, typically, likes the rigor and the discipline of the financial data. They feel uncomfortable with some of the more subjective data on a scorecard.

Others view the finance function as an indispensable part of defining how the organization creates value. The marketing people tell you where to sell. The product development people just launch new products and services. The operations people deliver products and services. It’s really the finance function that helps bring this together and asks if it is creating value.

So it’s potentially a very powerful role for that type of finance officer to play.

It sounds as if your view of finance executives has changed. In your first book, you wrote about their rigorous discipline, and you said that “these are not necessarily the traits required for managing a holistic, innovative, judgment-based, people-intensive management process” as in the balanced scorecard.

Kaplan (laughing): That’s not fair, quoting from our first book.

Maybe not, but a finance executive reading that passage would say “ouch.”

Norton: In the Old Economy, the finance function was the custodian of the system that set objectives, allocated resources, and then monitored how they were used. So now we move into the New Economy, and the system gets broader. You have continuous budgeting, [rolling forecasts,] things like that.

Now the question is, who is the custodian that runs the system, that manages the system, that updates the system over time? A new system is required, but I think the people [who] have the traditional finance background would logically inherit that responsibility.

In your new book, you note that CFO Jay Forbes of Nova Scotia Power proposed the balanced scorecard there. How often do CFOs lead the charge?

Norton: Maybe about 20 percent of the time. More often it comes from the strategic planning or human resources [departments]. Quality is another.

Kaplan: Because the CFO is sometimes not heavily involved, one aspect of the strategy-focused organization that has lagged is the integration with the budgeting system. It’s just less developed than the objective setting or [the links to] incentive systems, human resource systems, or communication systems. I think, however, if we don’t establish the link with budgeting, then the scorecard initiatives may wither.

Yet the balanced scorecard still starts with financial measures…

Kaplan: We start with the destination. What are we trying to achieve? We feel that what for-profit companies should be delivering is great financial performance.

Norton: If you look at the logic of the scorecard, the arrows all end up with financials, but they start with things like skills, technologies, and process design. Those are what you have to measure today to impact financial results tomorrow.

But you do point out that financial measures have their limitations. Are some more limiting than others?

Kaplan: I don’t think we’re unhappy with the financial measures. They’re good for what they are. And we’re certainly very comfortable with the newer financial metrics like EVA [economic value added] and other shareholder value-based metrics as the overarching objective. If you were just using earnings per share or net income, you’d run into problems of overinvestment–investing too much in capital to generate earnings or net income.

What impact has technology had on disseminating the balanced scorecard information?

Kaplan: The major ERP [enterprise resource planning] vendors all have an application called Enterprise Management that aligns with the functional standards that we have established.

But one of the consultants at Gartner said that traditional [ERP] systems could only capture about 40 percent of the measures from the balanced scorecard. Is that true?

Norton: Yes. Traditional ERP systems are transaction-driven, whereas on the scorecard you get into things like competencies, critical skills, market surveys, employee surveys, or you’ll get into measuring on-time delivery and things like that. A high percentage of that information does not exist in transaction systems. On the other hand, it’s not that big a deal to build the databases for the high-level [data] because it is not transaction data, it’s summary data.

What benefit are companies getting from stand-alone software products?

Norton: Most of the software has just come to the market in the past 12 months. So it’s hard to say. I know there are hundreds of installations now. I think there are about 10 organizations that have gone through certification, including SAP and Oracle, as well as a lot of new niche companies that have come into the marketplace.

In some cases, time and cost of implementation have been a deterrent to using the scorecard. Is the cycle time getting shorter? Is it getting any cheaper?

Kaplan: There are two aspects. One is, what does it cost to get one up and running, and how long does it take? The second is, what about the ongoing maintenance of the system? In terms of building the system, I think we’ve accelerated it, and the templates help that. In addition, the tools that will soon be available on our Web site will help people implement systems at [a] lower cost and faster [speed].

But there is a front-end expense. I don’t know how you’d quantify internal time versus external consultants and systems. Maybe it is measured in hundreds of thousands of dollars but not millions. [At the same time,] you’re getting billions of dollars of value creation. And if a CFO only thinks, “Can the organization afford $300,000 for a new measurement system?” he’s viewing it only as a measurement system. He’s not saying, “How much am I willing to pay to get the organization aligned to implement this strategy?”

Have you actually done any studies on the impact of the balanced scorecard on stock price/shareholder value?

Kaplan: A lot of the applications were done in divisions, not in the entire corporation. We talk about Mobil, but that was really a division. It was a big division, $20 billion, but maybe only 20 percent of the company.

Norton: When Cigna started this, however, they had negative shareholder value. The parent company was trying to sell it and had no takers. They introduced a new strategy; introduced the new scorecard. Five years later, they were sold for $3 billion. That’s [creating] shareholder value. Saachi & Saachi introduced the scorecard to try to create better segmentation in the way their branch offices were approaching the market. They introduced the scorecard, I believe, in 1997. Shareholder value at that time was $500 million. They were just acquired about six months ago, for $2.5 billion.

Does the balanced scorecard work in the New Economy, with its shorter cycle times and increased volatility?

Norton: If you’re a pharmaceutical company and it takes 10 years to bring a product to market, the scorecard will describe the steps you have to take to do that. If you’re a dot-com and it takes you 90 days to bring a new product to market, the scorecard will describe that. The major difference in the New Economy with the scorecard is the rate at which you learn, the rate at which things change.

Kaplan: You have to be very skilled in rapidly updating the scorecard in the New Economy, because as things change, you have the managerial challenge of getting the 100 or 500 people in your organization all aligned to the new direction. The scorecard turns out to be probably the most powerful tool these companies could have [to communicate] the new shared understanding. For it to work, however, it can’t take six months to update. Candidly, though, I don’t think the companies have recognized that if you want to be a very flexible, fast-moving organization, you need a mechanism to bring everybody along.

In 1997, the Harvard Business Review designated the balanced scorecard as one of the most important business developments of the previous 75 years. How do you think it will fare over the next 75?

Norton: I hope I’m here to answer that.

Kaplan: At least come back in the next 25 years, and we’ll see how we’re doing a third of the way through.